The perils of being Pandora

Pandora's going public, but before you jump to invest, read the company's …

The online world is buzzing over the news that Pandora radio is going public. After 11 years of operation, the company will offer $100 million in common stock, "as soon as practicable after the effective date of this Registration Statement," the audio streamer announced on its recent Security and Exchange Commission S-1 form.

This news is a major milestone in the history of Internet radio. Pandora says that it served 80 million registered users as of January 2011, and it signs up a new one every second. With 800,000 songs in its catalog, the Oakland, California company has cornered around half of all Internet radio listening among the top 20 online stations and networks in the United States, according to one survey.

"Since we launched the Pandora service in 2005, our listeners have created over 1.4 billion stations," the SEC document adds.

But despite revenue of $55.2 million in fiscal 2010 and $90.1 million in the nine months ended October 31, Pandora had respective net losses of $16.8 million and $0.3 million. And its statement is quite frank about the risks of a public venture, especially when it comes to copyright costs, competition, and advertising revenue.

"Internet radio is an emerging market and our current business and future prospects are difficult to evaluate," the disclosure warns. "The market for Internet radio has undergone rapid and dramatic changes in its relatively short history and is subject to significant challenges. As a result, the future revenue and income potential of our business is uncertain."

Here are some perils of being Pandora.

Royalties

Since Pandora began in 2000, the company has sometimes reported a profit. But it has also incurred huge operating losses and an accumulated deficit of $83.9 million.

"A key element of our strategy is to aggressively increase the number of listeners and listener hours to increase our market penetration," the S-1 statement notes. "However, as our number of listener hours increases, the royalties we pay for content acquisition also increase. We have not in the past generated, and may not in the future generate, sufficient revenue from the sale of advertising and subscriptions to offset such royalty expenses."

Back in 2009, Pandora was engaged in down-to-the-wire negotiations with SoundExchange, the entity that collects royalties on behalf of rightsholders. Keep in mind that federal law requires online streamers to pay royalties to both songwriters and performers, as opposed to over-the-air radio stations, who just pay the former.

With Pandora threatening to pull the plug and Congress getting involved, SoundExchange eventually agreed to terms that Pandora thought it could live with—"survivable royalty rates," as CEO Tim Westergren put it. But Pandora also announced that subscribers who listened to the service for more than 40 hours would now have to pay 99 cents a month.

"In essence, we're asking our heaviest users to put a dollar (well, almost a dollar) in the tip jar in any month in which they listen over 40 hours," Westergren explained.

The S-1 disclosure warns that Pandora is not out of the royalty woods yet. For the nine months ending on October 31, 2010, Pandora incurred "SoundExchange related content acquisition costs" to the tune of 45 percent of the company's total revenue for that time period:

To secure the rights to stream musical works embodied in sound recordings over the Internet, we obtain licenses from or for the benefit of copyright owners and pay royalties to copyright owners or their agents. Those who own copyrights in musical works are vigilant in protecting their rights and seek royalties that are very high in relation to the revenue that can be generated from the public performance of such works. There is no guarantee that the licenses available to us now will continue to be available in the future or that such licenses will be available at the royalty rates associated with the current licenses. If we are unable to secure and maintain rights to stream musical works or if we cannot do so on terms that are acceptable to us, our ability to stream music content to our listeners, and consequently our ability to attract and retain advertisers, will be adversely impacted.

The competition

As already noted, Pandora has cornered a huge chunk of the online music market. But the S-1 filing acknowledges that the field is fiercely competitive. Legal MP3 download services like iTunes are legion (to say nothing of the illegal sites). Then there's Last.fm, which is now charging for its mobile app service, Slacker Personal Radio, and Sirius XM. Overseas services such as Spotify could also make inroads into the US at some point in the future.

Meanwhile, terrestrial radio has been severely weakened by the broadband revolution but is still quite vibrant—in fact, the number of FM stations continues to grow. CBS and Clear Channel offer online services, such as iheartradio. And many terrestrial stations are being integrated into streaming meta-services like TuneIn radio.

But Pandora sees the biggest competition coming from less immediately obvious sources.

"In particular, if known incumbents in the digital media space such as Amazon, Apple, Facebook or Google choose to offer competing services, they may devote greater resources than we have available," Pandora warns. These competitors may enjoy a "more accelerated time frame for deployment and leverage their existing user base and proprietary technologies to provide products and services that our listeners and advertisers may view as superior."

Google

Finally, Pandora faces the same challenge as countless online entities—a reliance on Google for advertising revenue. Pandora depends on Google's DoubleClick service for ads. The S-1 statement acknowledges that Pandora can offer no guarantees that its DoubleClick deal will be extended on favorable terms following its expiration, or that Pandora could find an suitable alternative.

"Our agreement with DoubleClick also allows DoubleClick to terminate our relationship before the expiration of the agreement on the occurrence of certain events," the document notes, "including if DoubleClick determines that our use of its service could damage or cause injury to DoubleClick or reflect unfavorably on DoubleClick's reputation."

Some of these caveats come with a distinctly boilerplate tone—the obligatory warnings that you would expect a summary of this type to mention. But much of what Pandora has disclosed illuminates what a complex environment the online music/radio world has become.

As one of Pandora's first and current users (I got a free T-shirt!), I love the company and use the service daily.That said, I'm not sure I'd be lining up to invest at this juncture -

The competition is fierce in their market, and unless you can get a lot more users to pony up some dough for their premium subscription, I fear their future is uncertain.Maybe if they expand some their services and offer things like offline listening, direct album/song downloads for premium users (like mog) and jump the bitrate up for mobile devices I'd be a little more enthused about their prospects, and they might get a lot more premium subscribers.

"In particular, if known incumbents in the digital media space such as Amazon, Apple, Facebook or Google choose to offer competing services, they may devote greater resources than we have available"

This is the important bit. Amazon, Apple etc could afford to run a competing service at a loss so long as they use it as a loss-leader to drive download/other related sales, and easily keep that up until the likes of Pandora run out of cash. I give Pandora a snowball's chance in hell of long term survival. Then again, I am bitter since they pulled out of operating in the UK.

Pandora is pretty cool (I had a subscription last year). I like their desktop app, but it seems like Last.FM picks query-related songs much more to my liking than Pandora. Dunno why that is. Sounds like bullshit, I know, but, well, it is what it is.

I don't understand why anyone who enjoys the service wouldn't pony up $36. You get a much higher bit-rate, no ads and really great music. I just wish the higher bit-rate was available on my phone and Squeezebox.

I love the service, and I wish these guys the best. However, I see going public as a bad sign, as they'll be forced to make less consumer-friendly decisions to pay off their shareholders.

LazyCubicleMonkey wrote:

The commercials are bearable.

Yet this is the largest complaint I hear about Pandora. They're so infrequent, and they're not extraordinarily lengthy, yet some people just can't stand Pandora because of the commercials.

This idea of wanting things to be free and without ads is something I fear will hurt much of the internet right now. I subscribe to Pandora One, just as I subscribe to Ars, because I want them to stay in business, since I appreciate their services. If my finances were tighter, I would certainly be happy to see occasional ads instead. We need to understand that all of these things take work by people who need to support themeselves and their families, and we can't expect to get every nice thing for free just because they are digital and the distribution costs are negligible.

Question: if they created their own music or used music licensed under the creative commons license, do they still have to pay royalties? If so, why?

There isn't much music - or any material at all, really - that's got a Creative Commons license which allows for commercial reuse. Most (and, IIRC, it's the vast majority) of the works with a CC license are Share Alike - Non-Commercial - Attribution licenses; Pandora can't use those works without securing a separate license for them.

And of course, the material under a CC license isn't also licensed through a central body (such as ASCAP or SoundExchange), so in order to secure such licenses, Pandora would need to contact and negotiate with each individual rightsholder (typically the creator). It's completely infeasible.

Obviously, they could create their own music - but people, by and large, do not consider music a fungible resource. They want specific music, not substitute music.

"In particular, if known incumbents in the digital media space such as Amazon, Apple, Facebook or Google choose to offer competing services, they may devote greater resources than we have available"

This is the important bit. Amazon, Apple etc could afford to run a competing service at a loss so long as they use it as a loss-leader to drive download/other related sales, and easily keep that up until the likes of Pandora run out of cash. I give Pandora a snowball's chance in hell of long term survival. Then again, I am bitter since they pulled out of operating in the UK.

Perhaps, but if I am Amazon I would just buy Pandora instead. I really think Pandora's fate is to get bought out by someone anyway.

Question: if they created their own music or used music licensed under the creative commons license, do they still have to pay royalties? If so, why?

There isn't much music - or any material at all, really - that's got a Creative Commons license which allows for commercial reuse. Most (and, IIRC, it's the vast majority) of the works with a CC license are Share Alike - Non-Commercial - Attribution licenses; Pandora can't use those works without securing a separate license for them.

And of course, the material under a CC license isn't also licensed through a central body (such as ASCAP or SoundExchange), so in order to secure such licenses, Pandora would need to contact and negotiate with each individual rightsholder (typically the creator). It's completely infeasible.

Obviously, they could create their own music - but people, by and large, do not consider music a fungible resource. They want specific music, not substitute music.

The last sentence is the important part and is true. But regarding the details of the licensing agencies, you're slightly off.

ASCAP collects licensing for ASCAP members only, so you can theoretically avoid paying them, although its difficult. Plenty of horror stories of them hitting up little mom and pop bookstores or auto mechanics for licensing.

SoundExchange, to quote wikipedia, "is designated by the Librarian of Congress as the sole organization authorized to collect royalties paid by services making ephemeral phonorecords or digital audio transmissions of sound recordings." So no matter what you do, you can't opt out of paying SoundExchange, although the collected money is supposed to go to the performers.

I don't understand why anyone who enjoys the service wouldn't pony up $36. You get a much higher bit-rate, no ads and really great music. I just wish the higher bit-rate was available on my phone and Squeezebox.

Because many people are under the illusion that the Internet is a free-stuff machine and that they are entitled to media for free. Therefore, logically, anyone asking them for money is trying to rip them off.

ASCAP collects licensing for ASCAP members only, so you can theoretically avoid paying them, although its difficult. Plenty of horror stories of them hitting up little mom and pop bookstores or auto mechanics for licensing.

Well, there's *some* stories of overzealous ASCAP reps doing this. More often the sob story is a bar/club owner who pipes in recorded music (or has cover bands playing in their venue on a regular basis), gets sent multiple notices that he needs to pay licensing for it, ignores those notices and then gets sued for a whopping amount of money (which could have been avoided that they paid 1/10th of one busy night's revenue for the yearly licensing cost).

The story then gets posted by the owner, repeated by folks who don't understand the licensing issue, and turned into "well if the major labels are going to be assholes why should I pay for any music at all?" by those who want everything for free.

So yeah, once in a while ASCAP/BMI go overboard, and then those examples live on for eternity on the Internet, but by and large those "horror stories" are propagated by cheap club/bar/venue owners.

I listen to Pandora quite frequently. I don't mind the ads, so that is good value ( few adds, good music). I would pay if they offered a Mac client that does not use Java in any way, shape, or form. The use of Java requires me to run a separate browser for Pandora with two tabs - the second so that Pandora is not "active" - to avoid the Java CPU hog system. Awhile back I asked Pandora support if their client was Javaless and they said no, so I said no sale.

Madlyb wrote:

I don't understand why anyone who enjoys the service wouldn't pony up $36. You get a much higher bit-rate, no ads and really great music. I just wish the higher bit-rate was available on my phone and Squeezebox.

I love the service, and I wish these guys the best. However, I see going public as a bad sign, as they'll be forced to make less consumer-friendly decisions to pay off their shareholders.

LazyCubicleMonkey wrote:

The commercials are bearable.

Yet this is the largest complaint I hear about Pandora. They're so infrequent, and they're not extraordinarily lengthy, yet some people just can't stand Pandora because of the commercials.

This idea of wanting things to be free and without ads is something I fear will hurt much of the internet right now. I subscribe to Pandora One, just as I subscribe to Ars, because I want them to stay in business, since I appreciate their services. If my finances were tighter, I would certainly be happy to see occasional ads instead. We need to understand that all of these things take work by people who need to support themeselves and their families, and we can't expect to get every nice thing for free just because they are digital and the distribution costs are negligible.

I don't understand why anyone who enjoys the service wouldn't pony up $36. You get a much higher bit-rate, no ads and really great music. I just wish the higher bit-rate was available on my phone and Squeezebox.

Because many people are under the illusion that the Internet is a free-stuff machine and that they are entitled to media for free. Therefore, logically, anyone asking them for money is trying to rip them off.

Seriously.

+++

"free-stuff machine" is the best description of the perception of the internet I have heard yet.

Of course, it doesn't help when companies like Google go around buying services folks are willing to pay for, and then give them out for free, to support the only apparently profitable business on the internet. Advertising.

I listen to Pandora quite frequently. I don't mind the ads, so that is good value ( few adds, good music). I would pay if they offered a Mac client that does not use Java in any way, shape, or form. The use of Java requires me to run a separate browser for Pandora with two tabs - the second so that Pandora is not "active" - to avoid the Java CPU hog system. Awhile back I asked Pandora support if their client was Javaless and they said no, so I said no sale.

Isn't there an OS X Adobe AIR client for this, now? Or am I remembering wrong?

SoundExchange, to quote wikipedia, "is designated by the Librarian of Congress as the sole organization authorized to collect royalties paid by services making ephemeral phonorecords or digital audio transmissions of sound recordings." So no matter what you do, you can't opt out of paying SoundExchange, although the collected money is supposed to go to the performers.

I was unaware - so in that case, Pandora is legally barred from negotiating with creators who have licensed their music with a Creative Commons NS license, even if it were a feasible thing to do. It is interesting to me that, were I a musician, SoundExchange is legally mandated to get a cut of "my" royalties for digital broadcast.

megaman821 wrote:

Perhaps, but if I am Amazon I would just buy Pandora instead. I really think Pandora's fate is to get bought out by someone anyway.

I've been sort of hoping various other services would license the Music Genome Project/Pandora recommendation engine (I say that as though I blame those services for not doing so; I don't actually know if Pandora offers it). I listen to Pandora via my phone, but having to manually go through the bookmarks and purchase tracks via my music service du jour (previously ITMS, now the Zune marketplace) is sort of a pain. More importantly, as a Zune Pass listener, it would be fantastic to have MS' recommendations driven by Pandora's engine (and I assume the same would be said by users of the iTunes Genius, or Rhapsody, or what-have-you).

Frankly, the streaming service itself is the least important reason I use Pandora. I primarily want it to generate recommendations for me. In fact, if I could just have Pandora spit out its upcoming playlist (based on my station definition, obviously) in text form, even, I'd pay for the privilege. As it stands, I don't regularly pay because I can't get the high bitrate stream on my phone and I usually don't hit >40 hours for a month.

I listen to Pandora quite frequently. I don't mind the ads, so that is good value ( few adds, good music). I would pay if they offered a Mac client that does not use Java in any way, shape, or form. The use of Java requires me to run a separate browser for Pandora with two tabs - the second so that Pandora is not "active" - to avoid the Java CPU hog system. Awhile back I asked Pandora support if their client was Javaless and they said no, so I said no sale.

Isn't there an OS X Adobe AIR client for this, now? Or am I remembering wrong?

I know the Windows Desktop client runs off of Adobe Air, so I would imagine it would be similar on Mac. (Kind of the point of AIR I thought was Mac/Windows/Linux didn't matter to it?)

I listen to Pandora quite frequently. I don't mind the ads, so that is good value ( few adds, good music). I would pay if they offered a Mac client that does not use Java in any way, shape, or form. The use of Java requires me to run a separate browser for Pandora with two tabs - the second so that Pandora is not "active" - to avoid the Java CPU hog system. Awhile back I asked Pandora support if their client was Javaless and they said no, so I said no sale.

Isn't there an OS X Adobe AIR client for this, now? Or am I remembering wrong?

Yes, the Pandora One client is an AIR app. I'm not sure where swalsh76 is getting Java from.

I don't know why you all guys keep referring to similar services that are getting better. THERE ARE NO SIMILAR SERVICES!!! The music genome proyect is an awesome thing that has let me discover a few dozen new artists that right now I'm a fan of. I've tried Last FM, Mog, and even Spotify (through a VPN) and NONE compare. Most are search-and-listen services, and the ones that offer "pandora-like" services, don't even come near because they just catologue the songs by genre, not even near of what pandora does. Some claim about the advertisements...PAY, YOU CHEAP B*STARDS!!! It's 36 bucks a year...you spend more than that on apps, booz, girls, etc. Some complain about the few songs they have in library (800k vs millions of other services)...well, let's have you listen to every single song in that 800k library and dissect it as the Pandora team does it; NO OTHER SERVICE does that. The Pandora service simply rules: there's nothing in the world like it, and probably never will; I'd be happy to pay $50 bucks a year if that's what it takes to keep the service as good as it is now.I reaaaaaaaaally hope that going public doesn't screw this awesome service.

I don't understand why anyone who enjoys the service wouldn't pony up $36. You get a much higher bit-rate, no ads and really great music. I just wish the higher bit-rate was available on my phone and Squeezebox.

Because many people are under the illusion that the Internet is a free-stuff machine and that they are entitled to media for free. Therefore, logically, anyone asking them for money is trying to rip them off.

Seriously.

Interestingly, this appears to be doubly true for Ars Technica posters I am amazed at how many people here have no qualms whatsoever about content piracy, and feel entitled to get all their media over BitTorrent. Then they act as if the content providers should feel guilty for asking for money.

I listen to Pandora quite frequently. I don't mind the ads, so that is good value ( few adds, good music). I would pay if they offered a Mac client that does not use Java in any way, shape, or form. The use of Java requires me to run a separate browser for Pandora with two tabs - the second so that Pandora is not "active" - to avoid the Java CPU hog system. Awhile back I asked Pandora support if their client was Javaless and they said no, so I said no sale.

Isn't there an OS X Adobe AIR client for this, now? Or am I remembering wrong?

SoundExchange, to quote wikipedia, "is designated by the Librarian of Congress as the sole organization authorized to collect royalties paid by services making ephemeral phonorecords or digital audio transmissions of sound recordings." So no matter what you do, you can't opt out of paying SoundExchange, although the collected money is supposed to go to the performers.

I was unaware - so in that case, Pandora is legally barred from negotiating with creators who have licensed their music with a Creative Commons NS license, even if it were a feasible thing to do. It is interesting to me that, were I a musician, SoundExchange is legally mandated to get a cut of "my" royalties for digital broadcast.

Well, yes and no. The problem is that if you try to go outside the compulsory licensing system the reporting requirements go up so astronomically as to swamp any savings on the small bit of content that's available to them under a free license.

I don't listen to internet radio at all but I completely disagree that there should be royalty fees in the same manner as they currently are defined. Something needs to change and I believe this report helps to prove that.

Yet this is the largest complaint I hear about Pandora. They're so infrequent, and they're not extraordinarily lengthy, yet some people just can't stand Pandora because of the commercials.

I would have agreed with this statement about 2 months ago, but recently they've been playing ads almost every third song. I'm assuming this will make them more attractive when they go public, being able to up their ads/hour ratio. The other issue I have with it is that the ads are at least 15% louder than the music playing - which /really/ sucks when you've been jamming something particularly good and have the volume up >_<

Matthew Lasar / Matt writes for Ars Technica about media/technology history, intellectual property, the FCC, or the Internet in general. He teaches United States history and politics at the University of California at Santa Cruz.